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Tertiary markets can be fragile. Investors who have local knowledge of the market may be best positioned to succeed.

In rural towns and tertiary markets, investors can earn superior yields on apartment properties, according to some multifamily investment experts.

“A smart investor with a thoughtful strategy in healthy rural markets can certainly do very well,” says Jay Parsons, vice president for MPF Research.

In rural and tertiary markets, apartment investors can avoid much of the competition they face in busier markets. There is little risk that a developer will build new apartments that overwhelm the market. Potential property buyers can also skip the frenzied auction atmosphere they face in core markets, where sometimes dozens of investors fight to make the highest bid.

However, investors also need to take care. Tertiary markets can be fragile. Investors who have local knowledge of the market may be best positioned to succeed.

Finding a strong market

It’s possible to find rural areas and small cities where the demand for apartments is strong. “There are certainly many rural areas with minimal apartment vacancy,” says Parsons.

Investors can earn relatively high yields on apartment investments in these areas, compared to busier urban and suburban apartment markets. Cap rates for garden apartments in tertiary markets averaged 6.5 percent over the 12 months ending in June, according to Real Capital Analytics. That 1.7 percentage points greater than the 4.8 percent average cap rate for garden apartments in the top six metro areas for apartments.

Cap rates are higher in part because apartment investors face less competition to buy properties. The opportunities to invest are simply not large enough to attract institutional investors.

“There’s nothing wrong with Billings, Mont.,” says Jim Costello, senior vice president for RCA. “But institutional investors can’t put the dollars in there. It’s not worth the cost of a airplane flight to Billings.”

Apartment investors also typically don’t have to worry about overbuilding. These markets have high barriers to entry for development—though not in a traditional sense. Land is often available to build new multifamily, and construction costs can sometimes be less than in busy urban markets. “The barrier is the ability to find capital partners willing to invest in rural sites,” says Parsons.

Because of these factors, investors in rural and tertiary markets tend to be people who already have some connection to the market and local knowledge of the place. “Typically the investor universe for rural assets would be comprised of local players and small banks, of which there is a very limited pool in any given small market,” says Parsons.

Let the investor beware in tertiary markets

The risk in these markets is that many of them were hard hit during the recession and have experienced slow growth in the recovery.

“Job growth in rural and tertiary areas was much slower in this last expansion relative to urban areas than in previous expansions when job growth rates in both areas were similar,” says Barbara Byrne Denham, a senior economist in the research and economics department at Reis.  “More tertiary markets suffer from deeper economic problems than in the past.”

Overall these markets are not as strong or diverse at their big city cousins—that’s one of the reasons there is less competition to buy and develop in these areas.

“The rents in these markets are lower and have grown at a slower rate over the last five years, so developers are less incentivized to build in these areas,” says Denham.

Apartments in these markets can also face competition for relatively inexpensive single-family houses for sale. “Many of these tertiary markets do not have fast-growing housing prices either so the cost differential between buying vs. renting is not as significant,” she says. “So landlords face higher competition from the housing market as well.”

Even a strong rural market could change quickly. The demand for housing is typically dependent on a limited number of employers—often in the same industry.

“That means an apartment owner is heavily impacted if even one local business closes its doors,” says Parsons. “Your property can go from 100 percent occupied to 50 percent occupied very quickly, and unlike in a major market, you may not be able to “buy” a lot more demand simply by lowering rents. In some cases, the demand may not be there at any price point.”

All of these reasons give investors an advantage if they have local knowledge that can help them correctly assess the risks—and rewards—of investing in these rural and tertiary markets.

But now things are getting dicey.

The market for real estate investment trusts (REITs) has been choppy this year. Let me be more specific: The market for equity REITs has been choppy. Mortgage REITs – at least those inside the portfolios of two exchange-traded funds – have been on a quiet tear. It’s uncertain if that will continue.

Equity REITS hold claims on property; mortgage REITs hold paper. A mortgage REIT, in most instances, is an arbitrage in which issuers borrow money at the short end of the yield curve and lend or invest at the long end. Much like a bank, a mortgage REIT fares well when its funds can be obtained cheaply and lent dearly. For mortgage REIT issuers, the steeper the yield curve, the better.

There’s been some steepening, though it’s been rather ragged trend. At the start of the current fiscal year in October, the 2-10 year Treasury curve’s positive slope was 83 basis points (0.83 percent). Now, in mid-July, the yield spread is 98 bips. That 15-point hike translated into an 18.7 percent total return for holders of the VanEck Mortgage REIT Income ETF (NYSE Arca: MORT), a market cap- weighted index of about two dozen mortgage trusts.

VanEck Mortgage REIT ETF (Total Return, Closing Basis)

Embedded in that 18.7 percent gain has been a substantial cash yield. MORT holders have enjoyed a 6.96 percent annual payout from the ETFs’ underlying trusts.

Another exchange-traded portfolio of mortgage trusts has offered income-oriented investors a comparable combination of capital appreciation and cash throw-offs. The iShares Mortgage REIT Capped ETF (NYSE Arca: REM) gained 11.3 percent this fiscal year while spitting out an 8.7 percent annual dividend yield.

iShares Mortgage REIT Capped ETF (Total Return, Closing Basis, Adjusted for 1-for-4 Reverse Split)

Going forward, things may get dicey for these ETFs. A lot of volatility has been introduced since May, wrenching prices to test the resistance and support levels of their upchannels. The challenge now, as always, is the shape of yield curve.  Early in May, as the 2-10 year T-note spread widened to 106 basis points, both ETFs pushed upward to test overhead resistance, only to be followed by a carom shot to support below. The cycle repeated in June and July. Now investors see the ETFs near their support levels again.

So, is there enough downward momentum to pierce support and send prices lower? Or can the ETFs recover to stay within their upchannels a while longer?

The answer depends on your confidence in the shape of the yield curve. Inflation expectations drive the long end and those expectations have been softening. The Fed’s influence is felt more at the short end. Janet Yellen’s recent testimony before Congress was essentially a Goldilocks moment: She offered balm for virtually everyone. No help there.

Best advice? Hold your ETFs but keep a moving stop about 4 percent below the current support level.

Brad Zigler is WealthManagement’s Alternative Investments Editor. Previously, he was the head of Marketing, Research and Education for the Pacific Exchange’s (now NYSE Arca) option market and the iShares complex of exchange traded funds.

Exclusive research shows confidence in REITs’ abilities to weather any broader commercial real estate challenges.

The commercial real estate sector seems poised for a slowdown. But bulwarked by healthy balanced sheets and strong portfolios the sector’s publicly-traded firms, for the most part, should be able to deal with any challenges. In fact, it may be a time of opportunity for REITs that can snap up assets in opportunistic plays.

These were among the findings of NREI’s second research survey exploring the state of publicly-traded REITs.

Among the findings:

• Sentiment is most positive for industrial REITs and most negative for retail REITs.
• In a rising interest rate and tightening lending environment, REITs with strong balance sheets should be able to take advantage. But don’t necessarily expect REITs to be net buyers.
• Respondents still think property-level debt is the best avenue for tapping capital markets in the current environment.
• A plurality of respondents also think REITs should use cash to reposition or redevelop assets rather than other strategies.

But there is also caution in the air.

“The warning signs of a slowdown are clear,” one respondent to the survey wrote. “This is a great opportunity for REITs to reduce debt and plan for a weaker market.”

To merge or not?

Survey respondents were mixed on whether it’s a good time for REIT mergers and acquisitions. Overall, 47 percent of respondents indicated that it is a good time for REITs to pursue tie-ups. But more than two fifths of respondents (41 percent) said they weren’t sure. In addition, only 13 percent said it was a bad time for mergers.

In November 2016, retail REIT Regency Centers Corp. agreed to buy Equity One Inc. for $4.6 billion. That deal closed in early March.

But overall, M&A activity for REITs has been muted.

REIT mergers and acquisitions in the U.S. and Canada amounted to about $16.4 billion in 2016, according to SNL data provided to NREI. Activity was subdued across all commercial real estate sectors last year, according to industry observers.

“Overall M&A activity was down sharply because of a decline in portfolio sales and entity-level transactions,” says Jim Costello, a senior vice president at Real Capital Analytics (RCA), a New York City-based research firm. “The issue is that 2015 was the year of the mega-deal, with lots of entity-level and portfolio sales happening.”

In 2016, most public REITs experienced stock prices that were below net asset values, says Mark Bratt, senior director of retail capital markets for commercial real estate services firm CBRE. Therefore, the lower mergers and acquisitions activity was a function of REITs lacking sufficient capital and stock price valuations to carry out some of the transactions. The slower activity affected all REIT sectors, not just retail, according to Bratt.

Observers are not certain that 2017 will be a busy year of consolidations for the REIT sector. Bratt notes that the sector might go in another direction altogether.

“With lower stock prices it might be a good time for some companies to go private,” he says.

Bears and bulls

Respondents were asked to rank what REIT sectors would be at the top of their “buy” and “sell” list and were able to select up to three property types in both categories.

Industrial REITs surged to the top of the list in this year’s survey, with 46 percent of respondents naming the sector as being on their “buy” list. That was up 12 percentage points from last year, when 34 percent put in on their buy list.

Further, industrial REITs were only named on 9 percent of respondents’ “sell” lists, giving it the strongest net positive response in the survey.

Industrial REITs moved ahead of multifamily REITs, which were named as “buys” by 39 percent of respondents (up a touch from 37 percent in 2016 when multifamily topped the list.) But multifamily REITs were also named by 33 respondents on their “sell” lists.

Other sectors at the top of the “buy” rankings included medical office REITs (35 percent) and student housing REITs (24 percent).

Sentiment for retail REITs, meanwhile, was intensely bearish. Overall, 56 percent of respondents put retail REITs on their “sell” lists—up from 42 percent in 2016. Retail REITs only appeared on 11 percent of “buy” lists. That was down from 17 percent in 2016.

Other sectors that appeared on “sell” lists included office REITs (28 percent) and hospitality REITs (27 percent.)

Balance sheet acts

A majority of respondents indicated that they think REITs have been good at managing their balance sheets. Overall, 58 percent said that REIT balance sheets are “balanced” and another 14 percent said they have room to take on more debt. Only 28 percent said they felt that REIT balance sheets are “highly levered.” Those numbers were virtually unchanged from a year ago.

Respondents also see stability in the capital markets for REITs. Roughly one third of respondents said the availability of both equity (37 percent) and debt (41 percent) was unchanged from a year ago. About one fourth of respondents said equity (26 percent) and debt (24 percent) were more widely available. Fewer respondents said equity (19 percent) and debt (21 percent) were less widely available than 12 months ago.

“Banks [are] requiring more equity, which means they are lending less percentage-wise,” one respondent wrote. “With less leverage, you buy less, not more. So the opportunity is finding equity partners.”

In terms of raising capital, respondents again endorsed property-level debt (46 percent in 2017 vs. 51 percent in 2016) as the best avenue for REITs given current market conditions. Another 37 percent endorsed equity issuance (compared with 34 percent in 2016), while only 16 percent said secondary debt issuance was the best avenue (up slightly from 13 percent in 2016).

But an April report from Fitch said that the U.S. REIT sector has seen a “significant” increase in commercial bank borrowing in recent years. At the end of 2016, bank borrowing exposure, including outstanding amounts on unsecured revolving credit facilities and term loans, accounted for 16.5 percent of total debt. Although that is an improvement from the  18.8 percent a year ago, it is still hovering near a 10-year high and is well above the 8.5 percent from year-end 2010.

The “failure” of REITs to capitalize on the strength of the unsecured bond market to reduce bank borrowings is increasing liquidity and funding risk, according to Fitch. One concern of the elevated exposure is that REITs may max out bank borrowing now when financing is still available and not have enough “dry powder” in terms of financing options if credit starts to tighten.

“If one of those forms of capital goes away, that could be problematic, particularly if it is during a period where they need to access capital and they can’t do so any longer from their bank relationships,” says Steven Marks, managing director, corporate finance, at Fitch.

“Capital market access is extremely important to REITs,” adds Chris Wimmer, vice president and head of REITs at Morningstar Credit Ratings. REITs access capital through public, private, debt and equity sources. “To the extent that REITs can demonstrate access to each of those four quadrants, that gives them a better credit profile,” says Wimmer.

Part of what may be frustrating some ratings agencies is that the higher level of bank borrowing comes at a time when the bond market is quite robust. Yet REITs have been turning to the banks for financing for a couple of reasons. Banks have been aggressive in courting new business and are offering five- and seven-year loans. REITs may also be relying more on bank financing simply because of the flexibility it offers.

“What the commercial banking market provides is that it is not necessarily cheaper, but it is more flexible in the extent of the maturities,” says Philip Kibel, associate managing director, real estate finance, at Moody’s Investors Service. For example, REITs can get three-, five- or even seven-year debt that can fit nicely into their maturity schedules with no pre-payment penalties, he notes.

What to do next

In terms of deploying capital, about half of respondents (47 percent) said redeveloping or repositioning assets was what REITs should be doing with their cash. Other top responses included paying off debt (39 percent), acquiring assets (33 percent) and investing in core operations (24 percent). Only 12 percent supported share buybacks.

In terms of managing portfolios, it seems to be anyone’s guess as to what REITs will do. About 31 percent of respondents said they expect REIT portfolios to remain stable. And then about one fifth of respondents (21 percent) said REITs would be net acquirers, but about one quarter (28 percent) said they would be net sellers. Additionally, about one-fifth, 21 percent, admitted they weren’t sure what REITs would do with their portfolios.

Several respondents wrote about an opportunity that could be returning to the market soon: distressed assets.

“There is oversupply in pockets for multifamily and structural changes in retail,” a respondent wrote. “For those with good liquidity and cash flow, with low leverage, opportunities may surface in distressed assets.”

In projecting performance for the rest of the year, respondents are mixed on the outlook for publicly-traded REIT stock prices and total returns for the balance of 2017.

Overall, 43 percent of respondents said they expect publicly-traded REIT stock prices to increase. Another 22 percent said prices would be flat. And 35 percent said they would decrease. The number of respondents who expected a decrease jumped from 24 percent in 2016.

The picture is similar for total returns. Just under half of respondents (47 percent) expect total returns to increase for the balance of 2017. Another 22 percent said total returns would be flat and 31 percent expect a decrease (up from 20 percent in 2016).

At the end of the day, however, uncertainty remains an issue. No one is sure where the Trump administration is headed in terms of its policy and legislative goals. And that’s causing uncertainty in the economy as well. So perhaps the best strategy for REITs is just to sit tight and see what happens.

“These are uncertain economic times so I would just position company to have cash, not excessive debt and see what develops in Washington,” one respondent wrote.

Donna Mitchell and Beth Mattson-Teig contributed to this report.

Research Methodology

The NREI research report on the REITs was completed via online surveys distributed to readers in May. The survey yielded 380 responses. More than half of respondents reported their titles as Owner/Partner/President/Chairman/CEO/CFO. The results from the current research were compared against a prior study completed in 2016. The 2016 survey yielded 350 responses.

“That story about student housing outperforming on sales volume does not hold water anymore,” says James Costello, senior vice president with research firm Real Capital Analytics.

Earlier this year it seemed like student housing properties were immune from the slowdown in investment sales. Sales for other property types had slowed dramatically compared to 2016. But the volume of single-asset student housing properties bought and sold in the first months of 2017 matched the beginning of 2016, which proved to be a record year for the sector.

No longer.

“That story about student housing outperforming on sales volume does not hold water anymore,” says James Costello, senior vice president with Real Capital Analytics (RCA), a New York City-based research firm. “It was the case through 2016 even as the apartment market faltered. Now though, deal activity is falling for student housing was well.”

Sales volume down for student housing

Investors bought and sold $1.9 billion in student housing properties in the first quarter of 2017, according to RCA. The figure is down 31 percent compared to the $2.8 billion in properties that sold during the same period the year before. The fall is roughly equivalent to the fall in volume that has hit property sales for apartments overall. Investors bought and sold $27.0 billion in apartment properties in the first quarter of 2017, down 33 percent from the year before.

That comparison includes portfolios of student housing properties. For a few months early this year, single-asset student housing properties were faring better.

But the latest data has brought sales of even these single student housing properties closer in line with the rest of the apartment sector, according to RCA. Sales of single student housing properties were down 26 percent over the first five months of 2017 compared to the year before. “April and May were particularly tough for student housing,” says Costello.

The reason for slow sales may be as simple as the law of gravity—what goes up must come down, at least a little.

“We had an amazing year last year,” says Dorothy Jackman, senior managing director for the national student housing group at real estate services firm Colliers International. “Yes, this year’s volume is going to be down compared to that.”

Investors bought and sold an estimated $10 billion in student housing properties last year. The activity included Harrison Street’s privatization of Campus Crest and Scion’s purchase of University House. Last year “produced the largest volume of transactions in industry history—double the next closest year,” says Frederick Pierce, president and CEO of Pierce Education Properties, an investor, developer and manager of student housing communities.

Experts predict that investors will buy $4.0 billion to $5.0 billion in student housing assets in 2017. If that happens, 2017 will still be a very strong year for sales in the sector. “That range brackets the highest volume years in industry history, excluding the anomaly that portfolio sales brought to 2016,” says Pierce.

Little yield premium for student housing

Student housing sales volume did grow much faster than apartment property sales volume overall in recent years. That’s because student housing offered significantly higher yields.

“The student housing sector offered a stronger yield opportunity than garden apartments—nearly 30 basis points higher,” says Costello. “With a better yield opportunity, capital followed.”

However, that premium yield has gradually shrunk. Cap rates on sales of student housing properties averaged 5.9 percent in March 2017, according to RCA. That’s just 10 basis points higher than the average cap rate for multifamily properties overall, at 5.8 percent. Before 2014, cap rates for student housing properties were at least 20 basis points higher on average than cap rates on apartment assets.

“Not surprisingly, sometime after the better yields on offer went away, so eventually did the stronger growth in deal volume,” says Costello.

Long-term demand

Even without a premium yield, investors are still eager to invest in student housing. That eagerness will keep the volume of deals from falling too far. “The market has an appetite to buy more. People are hungry for deals right now,” says Jackman.

“What matters most is that student housing in general is and will remain a technically and fundamentally sound investment class due to its recession-resistant investment characteristics, strong Generation Z demographic trends and sustained institutional and cross-border investor demand,” says John Strockis, senior vice president of acquisitions with SmartStop Asset Management, an asset manager that manages student housing, seniors housing and self-storage properties.

Single-asset transactions drove sales velocity last year, but the market has shifted back toward large portfolio deals.

Industrial sales in 2017 are expected to exceed 2016 totals, and are estimated to be at the second highest volume since 2007. Sales so far this year total $24 billion, with 245 million sq. ft. of industrial space trading hands, according to John Huguenard, international director of industrial capital markets Americas with real estate services firm JLL. In May, the most recent month for which data is available, sales of industrial properties rose 23 percent year-over-year, to $5.2 billion, according to Real Capital Analytics (RCA), a New York City-based research firm.

U.S. industrial sales peaked in 2015, but sales velocity has remained robust through 2016, when $47.8 billion in industrial properties were sold.

Single-asset transactions drove sales velocity last year, but Huguenard notes that the market has shifted back toward large portfolio deals. The most recent example of this is Canadian investment firm Ivanhoe Cambridge completing an acquisition of Evergreen Industrial Properties, a U.S. owner of light industrial properties, from TPG Properties. (The transaction price has not been disclosed).

Many investors complain about the lack of product to buy, and Huguenard concurs that there are fewer opportunities for smaller investors in the marketplace today. “But as long as there are buyers, those investing can find sellers,” he says, citing recent deals.

Three Boston-based industrial portfolio owners recently sold out, including Cabot Properties, Inc., which sold its 19.8-million-sq.-ft. portfolio to New York City-based DRA Advisors LLC for $1.07 billion; High Street Realty Co., which sold a 6-million-sq.-ft. portfolio to Blackstone Real Estate Income Trust for $402 million; and TA Realty, which sold a 45-property, 8.6-million-sq.-ft. office/industrial portfolio to the Brookfield Premier Real Estate Partners fund for $845.5 million. Approximately 7.5 million sq. ft. in the TA Realty portfolio was industrial product.

Attracted by record rent growth, foreign investors continue to snap up large U.S. industrial portfolios, Huguenard says. Most recently, China Life Insurance Group paid $950 million for a 95 percent stake in a 48-property, 5.5-million-sq.-ft. portfolio of small-market industrial facilities across the U.S., which was sold by Elmtree Funds LLC.

According to JLL’s first quarter 2017 Industrial Outlook report, the U.S. industrial sector has experienced six consecutive years of rent growth. Rent growth has exceeded 10 percent annually in the top four U.S. markets, including Northern New Jersey, South Florida, Seattle and the Inland Empire. Meanwhile, vacancy simultaneously hit new lows. Cap rates have dropped to 4-4.5 percent in these markets. The average cap rate on sales of industrial properties nationwide was 6.8 percent in May, according to RCA. That was in line with average industrial cap rates in 2016 and the average cap rate at the peak of the market in 2007. For most of the past decade, industrial cap rates averaged in the 7.1-8.3 percent range.

“Properties are getting pricey, and people keep saying cap rates can’t go any lower, but that’s been proven wrong,” says Huguenard. The average class-A cap rate across all U.S. primary markets was 4.7 percent in the second quarter of 2017, according to JLL. Investors are willing to pay higher values because they’re making good returns. “I’ve been in this business for 25 years, and for the first time in my career industrial is the most favored property type globally,” Huguenard says.

Part of the favorable outlook for the industrial sector can be attributed to developers of speculative projects exercising more restraint this time around than they did in the last real estate cycle. Product deliveries over the last five years have fallen short of increasing demand for space. Last year, 225 million sq. ft. of new space was delivered, and about 260 million sq. ft. was absorbed. Estimates for 2017 say that 250 to 260 million sq. ft. of industrial space will be delivered, and users are expected to absorb about 300 million sq. ft.

Increasing demand for instant delivery services by e-commerce consumers has also generated a need for smaller distribution facilities in dense, urban locations, according to a first quarter 2017 CBRE report from CBRE.

As a result, developers are focusing on infill sites in highly populated intercity markets, including Chicago, New York, Miami, Seattle and Los Angeles, to build new distribution facilities to serve last-mile e-commerce users, or are buying old buildings and replacing them with new product.

Increasing demand for last-mile distribution space has opened the door to a whole investment area, Huguenard says, noting that buyer competition for urban industrial properties is lifting values for class-B industrial assets.

In May, the percentage of survey respondents who said they were “not sure” where we are in the cycle rose to 10 percent.

Readers surveyed by NREI seem to be less confident about calling which phase of the market cycle we are in than they have been in recent months. In May, the percentage of survey respondents who said they were “not sure” where we are in the cycle rose to 10 percent, up from 5 percent in March and 9 percent in February.

At the same time, more respondents think the market has hit a peak (47 percent, the highest reading since the fall of 2016). Fewer readers said we are in an expansion phase, at 35 percent vs. 36 percent in March and 39 percent in February.

Four percent of readers said the market is in a trough, the same percentage as in March. The reading was down from 8 percent in February.

NREI conducts periodic studies of the commercial real estate sector. As part of those surveys, there is always a question on the estimation of the current state of the commercial real estate cycle. A typical NREI survey garners between 200 and 400 respondents. More than half of those respondents are typically owner/partner/president/chairman/CEO or CFO-level executives.

Lawmakers want to increase due diligence on real estate transactions executed by foreign owners.

Commercial real estate in the U.S. has always been—and likely will always be—open to foreign investors. In some cases, however, the federal government believes foreign ownership’s details are not transparent enough, at least when foreign entities end up owning buildings where federal agencies conduct high-security affairs and handle sensitive information.

On May 16, three ranking members of the Senate Finance, Homeland Security, Government Affairs and Banking, Housing and Urban Affairs committees raised concerns about how the Committee on Foreign Investment in the United States (CFIUS) reviews pending real estate transactions. In a joint letter to the Government Accountability Office (GAO), Senators Ron Wyden (D-OR), Claire McCaskill (D-Mo.) and Sherrod Brown (D-Ohio) asked the agency to review the CFIUS approach, citing growing questions about how national security could be impacted by certain real estate transactions.

On the same day that the senators sent the letter, Rep. Stephen Lynch (D-Mass.), introduced legislation requiring that foreign property owners reveal beneficial ownership whenever a federal agency leases high-security space from a private landlord for classified operations or to store sensitive data. In wording that fully expressed Lynch’s concerns, the bill is called the “Secure Government Buildings from Espionage Act of 2017.”

The moves come as news feeds bring new revelations—almost on a daily basis—of large-scale cyber attacks and investigations unfold into national elections compromised by outside forces.

Concerns have also been raised about foreign investors potentially using profits from U.S. real estate investment to fund terrorist organizations and criminal activities. In mid-June, the United Arab Emirates ambassador to Washington Yousef Al Otaiba accused the government of Qatar of using money brought in by the Qatar Investment Authority to support Hamas, the Muslim Brotherhood and groups with links to al Qaeda. In the first quarter of 2017, Qatar invested in 16 properties in the U.S., for a total of $1.9 billion, according to Real Capital Analytics (RCA), a New York City-based research firm. The country ranked 11th out of 25 on the list of top foreign buyers of U.S. commercial real estate, and this has been a slow quarter as Qatar’s acquisition volume was down 65 percent year-over-year.

Now lawmakers want to increase due diligence on real estate transactions executed by foreign owners.

The increased scrutiny comes on the heels of a strong year for foreign investment in 2016, when the office sector attracted a high volume of offshore capital, according to research from real estate services firm JLL. In 2016, foreign office investment exceeded $20 billion and accounted for 16 percent of overall acquisition activity for the second consecutive year, according to JLL’s “Office Investment Outlook,” for the fourth quarter of 2016, the most recent available.

“With the increase of foreign investments it is a question of … the transparency of the owners,” says Anne Salladin, a special counsel at Strook & Stroock & Lavan, an international law firm based in New York City. “It is just making sure the government has the correct information.”

The question is: could the closer scrutiny slow down an active part of the market?

Federal agencies appear to have reason for concern. In a letter of support for the Secure Government Buildings Act, directors for the FACT Coalition noted that at least 20 office spaces and facilities leased by the Government Services Administration had foreign owners, citing a GAO analysis published in January.

Most of the foreign landlords on the GAO list are based in countries that are strong allies of the U.S., including Germany, the United Kingdom and Israel. For instance, Winnipeg, Canada-based Artis REIT leases 210,202 sq. ft. of space to the Federal Bureau of Investigations in a building in Phoenix. Also, Korea Investment Holdings leases 862,292 sq. ft. of space in a building on Market Street in Philadelphia to the Internal Revenue Service, the Inspector General for Tax Administration and the Department of Homeland Security. The company is based in South Korea.

So where is the cause for concern? The GAO analysis also notes that China-based Gaw Capital leases about 159,155 sq. ft. of space in a Seattle building to the Social Security Administration and the GAO itself.

China’s representation on the foreign landlords list was small, and in most cases the properties were jointly owned, according to the GAO’s analysis. But the Asian giant continues to be a major buyer of U.S. properties. In the first quarter alone, China invested in 515 U.S. properties, spending a total of $16.5 billion, according to the RCA—a 10 percent increase compared to the same period in 2016. It was the number one source of foreign capital flowing into U.S. commercial assets.

Middle Eastern countries, including Israel, Qatar, Saudi Arabia and Kuwait, jointly spent $7.5 billion on U.S. properties in the first quarter, with Saudi Arabia raising its investment volume by 2.5 percent year-over-year, to $1.8 billion, and Kuwait by 1.4 percent, to 1.0 billion.

Just as the profile of foreign buyers is shifting, so are ideas of what constitutes national security.

“It used to be about defense; then it was telecommunications,” says Chris Griner, a partner at Stroock & Stroock & Lavan, who had also worked in the office of general counsel for the Department of Defense. “Now it is critical infrastructure, and it could be banking, finance or medical. There are a whole bunch of things on top of that. There is no single definition of what is national security.”

Griner also co-authored a note on lawmakers’ efforts to increase scrutiny of commercial real estate transactions involving foreign owners.

It is unclear how much momentum is behind Lynch’s sponsored bill. Griner, however, is confident that increased transparency doesn’t necessarily bode ill for the sector.

“The U.S. is a great economy to invest in for real estate,” he said. “We see nothing that will slow things down.”

Investors are betting on non-prime mortgages once again, according to the Wall Street Journal. The State Department spent thousands of dollars on room bookings at the Trump hotel in Vancouver in February, reports the Washington Post. Here are today’s must reads from around the commercial real estate industry.

1. Condo Developers Bet Jersey City Will be the Next Brooklyn “Nine years after the last condominium craze faded away in Jersey City, N.J., condos are finally staging a comeback. Two new tall condo projects are launching sales this week in Jersey City, with more than 670 apartments in a variety of styles, finishes and prices.” (Wall Street Journal, subscription required)
2. Warren Buffett’s REITs “Warren Buffett is picky about his real estate investment trusts. Of the 200 REITs publicly traded in the U.S., Buffett has purchased only one for his 47-stock portfolio at Berkshire Hathaway and one more for his personal holdings. Buffett purchased both of the REITs in the past two years, suggesting an increase in interest in the sector or in their attractiveness. An analysis shows what his picks have in common and how they align with his stated investment criteria.” (Forbes)
3. A Big Deal in Nonprime Mortgages Proves Leery Investors are Hungry Again “The appetite for riskier mortgages is rising, and a small cadre of investment firms is ready to feed it. Angel Oak Capital Advisors just announced its second rated securitization of nonprime residential mortgages this year, a deal worth just more than $210 million and its largest ever. Its first deal was slightly less, but demand from borrowers and investors alike is growing, and the securitizations are growing with it.” (CNBC)
4. Pittsburgh Proposes Turning VA Property into Law Enforcement and EMS Center“Pittsburgh officials have proposed turning a 164-acre former Veterans Affairs site into a law enforcement center after the federal government declared it excess property. Mayor William Peduto’s Chief of Staff Kevin Acklin testified Wednesday morning before a U.S. House of Representatives subcommittee on the proposal to turn the VA property in Lincoln-Lemington into a law enforcement and emergency management center.” (Pittsburgh Post-Gazette)
5. State Department Spent More Than $15,000 for Rooms at New Trump Hotel in Vancouver “The State Department spent more than $15,000 to book 19 rooms at the new Trump hotel in Vancouver when members of President Trump’s family headlined the grand opening of the tower in late February. The hotel bookings — which were released to The Washington Post under a Freedom of Information Act request — reflect the first evidence of State Department expenditures at a Trump-branded property since President Trump took office in January.” (Washington Post)
6. Here’s How Much Money the GM Building Makes “Harry Macklowe may not want to look at these numbers. The GM Building, which the developer lost during the 2008 financial crisis, could make a whopping $184.3 million annually in net operating income over the coming years, according to a new analysis from Fitch Ratings. After deducting debt payments and capital expenses that would still leave the building’s owner, Boston Properties, with an annual profit of close to $90 million.” (The Real Deal)
7. This is Wayback Burgers’ Answer to Skyrocketing Manhattan Rents “Wayback Burgers has found a solution to sky-high rent in New York City — a 5-by-10-foot food cart. Since its first store opened up in 1991, Wayback Burgers has been steadily growing. The chain currently has more than 120 locations in 27 states, but it has yet to penetrate the New York City market. That is, until now. The private burger chain has partnered with Move Systems, a food cart and truck manufacturer, to gain a foothold in the Big Apple.” (CNBC)
8. ‘Google Effect’ Could Raise Real Estate Prices in Downtown San Jose “A new example of what might be called the “Google effect” is leading real estate speculators to drop big money on properties in downtown San Jose. East coast investors just bought an $80 million office building near the Diridon Station, not far from where Google is set to build a huge new campus. The building sits at the crossroads of Almaden and San Carlos streets. But the sale of 303 Almaden also crosses a price line never seen in the downtown area.” (CBS SF Bay Area)
9. Sales at Apple’s Fifth Avenue Store Plummet by Over $100M “When pessimists gripe that the rise of online retail spells doom for Manhattan’s brick-and-mortar shops, optimists often counter by pointing to Apple’s store on Fifth Avenue. The famous glass cube has been a phenomenal success, generating billions in revenue and becoming one of the most profitable stores in the world. But newly released numbers, buried in a Fitch Ratings report on the GM Building, should give even the optimists cause for concern.” (The Real Deal)
10. J.C. Penney to Add Toy Sections in All Stores “Department store operator J.C. Penney Co Inc said it was opening toy shops in all its stores and has already doubled its online assortment of toys over the last year, with plans to expand further by the holiday season. The retailer, which has over 1,000 stores, will sell toys from brands including Mattel’s Fisher Price, Hasbro and Playmobil, with some stores also featuring a play area.” (Reuters)